Retail Industry Getting Squeezed As Credit Insurers Take Fright!
by Paul Scott
A recent Sunday Times article had worrying news in the business section, revealing that a leading trade credit insurance company, Atradius, has cut cover on AO World. It says this could lead to cashflow problems, and possibly a cash call on shareholders. This is a timely reminder that trade credit insurance is incredibly important, and its withdrawal can push companies into insolvency.
I recall a crisis in 2016, at one incarnation of the GAME computer games shops. Its balance sheet actually looked OK, but the biggest trade credit insurer took fright about the company’s future prospects, withdrew/reduced cover, and the shares plummeted, never to recover previous highs. Although insolvency was averted in that case, with a new credit line being put in place from a major shareholder in 2016, which propped up the company.
This article from the Guardian in 2016 is a useful read. It reminds us that removal of trade credit insurance played a part in causing the insolvency of retailers Woolworth, Focus DIY, and Zavvi.
For anyone not familiar with trade credit insurance, it is an insurance product which suppliers use, to guarantee they will get paid, even in the event of the customer going bust.
You only have to look at the balance sheets of any company, to see that many often owe their suppliers (within trade payables) more money than they owe the bank. Therefore, suppliers’ confidence in any company’s solvency is a critically important factor in whether the supplier is prepared to sell products or services on the usual 30-60 days credit payment terms. If suppliers are worried they may not get paid, then they often start demanding some or all of the money up-front, before dispatching goods. That causes a cash squeeze at the customer, who might then be forced into administration, if their cashflow dries up. And of course if suppliers refuse to supply products, because they’re worried about the customer going bust, then that’s it for the customer – game over, since it rapidly runs out of products to sell.
I remember battling with this very issue, over a long period of time, in my days as a CFO in the 1990s. Every time the trade credit insurer pulled the rug out from under us, it plunged the company into a financial crisis. I managed to solve the problems every time, but it was a serious threat to the business, multiple times.
Let’s look at Matalan for instance. This discount clothing retailer is a private business, but a very interesting situation. It’s overloaded with debt, and the founder John Hargreaves was hit with a huge back-dated tax bill – itself a fascinating case here. I’ve just been reading it. He relocated to Monaco, in order to avoid capital gains tax on a large sale of Matalan shares made shortly afterwards. However, the court decided that his links to the UK, and time spent here, meant that he wasn’t an overseas resident in that tax year. Oops! (trying to suppress schadenfreude here).
There’s currently a battle for control of Matalan, with a number of parties submitting bids, including Hargreaves.
One of the reasons Matalan is struggling financially is because trade credit insurers have reduced/withdrawn cover. This is a really important theme right now, that I’ve mentioned many times before. In times of financial trouble, either generally, or at an individual company, trade credit insurers often withdraw cover, which can cause companies to go bust, unable to persuade suppliers to send in fresh deliveries of goods.
We need to be vigilant about this, particularly for struggling retailers, and other consumer-facing sectors which are under pressure.
Hence why strong balance sheets are vital at the moment. Ignore bank debt at your peril! But often debt owed to suppliers (trade creditors) is even larger than the bank debt, and often those trade creditors rely on insurance cover.
Matalan has faced debts of over £500 million and has come under increased pressure in recent months after leading credit insurers, including Allianz Trade, gradually removed cover for suppliers to the retailer.
Given current macro conditions, with an economic slowdown looking increasingly likely, and profits likely to be squeezed badly in some sectors, then investors really need to think carefully about the risk from possible withdrawal of trade credit insurance. Consumer-facing sectors look the most vulnerable.
A good question to ask management on webinars, is whether trade credit insurers have reduced cover available to their suppliers?